China pledges to keep yuan stable, but speculation of rise swirls

By Zhou Xin
and Emily Kaiser / Reuters, BEIJING

China’s central bank said on Friday it aimed to keep the currency exchange rate relatively stable, but the pronouncement did little to quiet speculation that Beijing would allow swifter yuan appreciation to help stem inflation.

The People’s Bank of China (PBOC) said in a quarterly report that it would use “multiple policy tools” including interest rates, exchange rates and bank reserve requirements to try to keep prices in check. The wording in the report was similar to its previous one.

It repeated that it would keep the yuan exchange rate basically stable at a “reasonable and balanced level.”

However, talk swirled that the central bank was preparing a policy move. A flurry of stories in local newspapers affiliated with the government suggested that the PBOC would increasingly use a stronger currency to help it manage imported inflation as the US dollar weakens.

It was not clear whether the PBOC’s report was written before or after those stories were published on Friday. The report made a reference to the US debt rating downgrade on Aug. 5, indicating it was finalized within the past week.

“We will reasonably use price tools such as interest rates to adjust capital demand and investment/saving behavior to manage inflationary expectations,” the PBOC said.

It said there should be no let-up in the fight against inflation, indicating price pressures remained a primary concern even though many economists think inflation peaked last month.

“The foundation of stabilizing prices is still not solid enough, and the situation is not optimistic,” the bank said.

The media reports, which appeared in half a dozen newspapers in a rare display of uniformity, augmented market speculation that a PBOC policy change was imminent, perhaps involving a widening of the trading band for the currency.

The yuan steadied to around 6.39 to the dollar in spot markets on Friday, pausing after a steep rise last week, as the PBOC set a record-high mid-point for the yuan for a third consecutive day.

It has now appreciated about 6.7 percent since it was depegged from the US dollar in June last year and 3 percent so far this year.

YUAN’S CASE

Beijing routinely faces pressure from the IMF, the US and others to allow the yuan to rise more rapidly.

There are at least three reasons why a stronger currency would make sense for China now.

Data released last week showed inflation last month unexpectedly accelerated to 6.5 percent year-on-year, while exports held up well in the face of sluggish US and European economic growth. A stronger currency would help blunt imported inflationary pressures, and healthy exports suggest businesses can tolerate a rise.

The US debt downgrade and festering European debt crisis have renewed questions about China’s heavy foreign debt holdings. A strengthening yuan would slow the accumulation of reserves and reduce the need to recycle them into dollar or euro-denominated assets.

The US Federal Reserve’s pledge last week to keep interest rates ultra-low for at least two more years has heightened speculation that it may launch another round of bond purchases. The last round drove up commodity prices and sent a wave of speculative money into emerging markets, fanning inflation.

BNP Paribas economists said that a swifter yuan rise “looks logical” if China is sufficiently confident that its economy can weather a global economic slowdown.